Bank-Bailout Lessons

In Europe’s endless crisis, the latest focus is Spain’s banks. Some €31 billion in deposits fled Spanish lenders in April, the second largest monthly capital flight from Spain in the euro era. Last Friday’s news that Bankia—the country’s fourth largest bank and second largest mortgage lender—needs at least €19 billion to stay afloat has raised doubts, to put it mildly, about Prime Minister Mariano Rajoy’s insistence that Madrid will put no more money into the country’s banks.

What to do? As with Tolstoy’s famous dictum about unhappy families, each troubled lender is troubled in its own way. But the recent record on bank bailouts in Europe and the U.S. carries more than a few lessons for Mr. Rajoy and other politicians forced to confront financial insolvency. Five lessons in particular stand out.

• Move quickly to administer life support, and then move quickly to get out.

Way back in 2008, at the height of the global financial panic, the British government took dramatic steps to nationalize Royal Bank of Scotland and Lloyds TSB. A £20 billion injection was exchanged for a 58% stake in RBS, and £17 billion bought 40% of Lloyds.

Under government stewardship, both institutions have faced populist wrangling over executive bonuses, round after round of re-recapitalizations, and a government diktat to start rebuilding their balance sheets by lending to small businesses. Four years later, the British government is sitting on about 60% losses on both investments. Management by regulators and politicians, it turns out, doesn’t engender peak performance.

• Avoid piecemeal solutions, even if that means higher upfront costs.

Mario Draghi, the President of the European Central Bank, took Madrid to task Thursday for repeatedly lowballing the cost of saving Bankia. “There is a first assessment, then a second, a third, a fourth,” Mr. Draghi told the European Parliament. “This is the worst possible way of doing things. Everyone ends up doing the right thing, but at the highest cost.” He’s right.


Associated Press

Spanish Prime Minister Mariano Rajoy.

In Spain’s case, it’s worth recalling that any bank bailouts in the months ahead would already constitute a second round of government action. In 2009 Madrid set up a multibillion-euro bank-rescue fund—the Fund for Orderly Bank Restructuring, or FROB—and demanded that banks write down their dodgy real-estate loans and raise new funds. Bankia was formed in 2010 as a merger of seven savings banks, in a wave of consolidations that was supposed to help lenders cut costs and weed out the weaker links.

How long ago that seems. The FROB only has about €5 billion left, and only the Spanish government seems to think that’s enough to avert a crash.

• Establish and stick to a strict limiting principle for deciding which banks get rescued, and which are allowed to fail.

In 2008, Washington’s signature response to the financial panic was the $700 billion Troubled Asset Relief Program (TARP). At the time, we supported TARP as a resolution agency for holding distressed assets and working them off over time. But among the reasons that bankers and voters soured on TARP was that the rules governing assistance were left opaque—when there were rules at all.

Establishing a limiting principle for bank aid will never be easy, but granting regulators too much discretion about which lenders to save and which to let go will lead to endless picking and choosing. Better to draw a line and risk the ire of the lenders who don’t get rescued than to turn the process into a prolonged bidding war. Not every bank can or should be saved by the state.

On this front, the previous Spanish government did well. These columns lauded the Socialist government of José Rodriguez Zapatero for getting out in front of the problems at the banks, giving the cajas clear objectives to meet or else face nationalization. Until recently, Mr. Rajoy’s rescue strategy has been to deny that Spanish lenders need an EU rescue.

• Don’t follow Dublin.

Ireland’s private-debt problem became a sovereign-debt problem in 2008 when the Irish government offered blanket guarantees for all bank creditors on the assumption that they wouldn’t actually need the help. What then-Finance Minister Brian Lenihan called “the cheapest bailout in history” turned out to be among the most expensive.

• Beware the temptation of a “banking union.”

That’s the latest brainstorm from Brussels. The idea, offered in a European Commission report on Wednesday, is to socialize the cost of bank recapitalizations by funneling money to the banks directly from the European Stability Mechanism. Currently, ESM funds are intended to go only to national governments.

A banking union might spare Mr. Rajoy the humiliation of accepting an EU rescue. But such a union would also require a pan-European bank supervisor, and it’s not obvious that Brussels has the expertise to serve as a regulator and inspector for financial institutions throughout the Continent. More importantly, Mr. Rajoy needs to consider carefully whether Madrid will be ready to take orders from Brussels if its conditions for tapping the ESM prove to be politically unpopular with Spaniards. For evidence of where that may lead, see the streets of Athens.

None of this suggests that the road forward for Spain will be easy, much less cheap. But the approach Mr. Rajoy would seem to prefer—denial—is no solution at all.

A version of this article appeared June 1, 2012, on page A12 in the U.S. edition of The Wall Street Journal, with the headline: Bank Bailout Lessons.


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